F5 - PM - Pocket Notes - 2019
Performance Management
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Performance Management (PM)
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Pocket Notes
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Performance Management (PM)
A catalogue record for this book is available
from the British Library.
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Published by:
Kaplan Publishing UK
Unit 2 The Business Centre
Molly Millars Lane
Wokingham
Berkshire
RG41 2QZ
ISBN 978-1-78740-121-1
© Kaplan Financial Limited, 2018
Printed and bound in Great Britain.
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British library
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The text in this material and any others
made available by any Kaplan Group
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Performance Management (PM)
Contents
Chapter 1:
A revision of Management Accounting (MA) topics .....................................................1
Chapter 2:
Advanced costing methods............................................................................................5
Cost volume profit analysis ..........................................................................................19
Chapter 4:
Planning with limiting factors .......................................................................................27
Chapter 5:
Pricing ..........................................................................................................................35
Chapter 6:
Relevant costing ..........................................................................................................43
Chapter 7:
Risk and uncertainty ..................................................................................................49
Chapter 8:
Budgeting ...................................................................................................................57
Chapter 9:
Quantitative analysis ...................................................................................................75
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Chapter 3:
Chapter 10: Advanced variances ....................................................................................................81
Chapter 11: Performance measurement and control .....................................................................93
Chapter 12: Transfer pricing and divisional performance measurements .....................................101
Chapter 13: Performance measurement in not-for-profit organisations ........................................109
Chapter 14: Performance management and information systems ................................................113
Index
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Performance Management (PM)
The examiner’s key concerns
Section A of the examination comprises
15 objective test questions (OT) of 2
marks each. Section B comprises three
objective test cases (OT cases), each of
which includes 5 OT questions of 2 marks
each. Section C comprises two 20 marks
constructed response (i.e. long) questions.
•
Students need to be able to interpret
any numbers they calculate and see the
limitations of their financial analysis.
•
In particular financial performance
indicators may give a limited perspective
and NFPIs are often needed to see the
full picture.
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The exam
There will be an even mixture of written
requirements and computational
requirements. The Section A and Section B
questions can cover any area of the syllabus.
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The two 20 mark questions in Section
C will test decision-making techniques,
budgeting and control and/or performance
measurement and control areas of the
syllabus.
P.4
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Questions will be practical and realistic,
so will not dwell on unnecessary
academic complications.
•
Many questions will be designed so
discussion aspects can be attempted
even if students have struggled with
calculation aspects.
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Performance Management (PM)
Time management
Our Quality Co-ordinator will work with our
technical team to verify the error and take
action to ensure it is corrected in future
editions.
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A common problem on this type of paper is
that students spend too long on calculations
and don’t have enough time to do themselves
justice on the discussion aspects. Allocate
your time and stick to it!
Quality and accuracy are of the utmost
importance to us so if you spot an error in
any of our products, please send an email
to mykaplanreporting@kaplan.com with full
details, or follow the link to the feedback
form in MyKaplan.
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Exam technique
Question requirements and answer content
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Ensure you read each question requirement
at least twice before you start, and again
when you have finished answering it. Have
you actually addressed the requirement? If
the question says for example, ‘discuss the
issues to be considered when switching
to ZBB’ – don’t then simply describe ZBB;
discuss the issues when switching!
Reading time
The 15 minutes reading time should be
spent on reading and planning to develop a
structure to your answers.
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Performance Management (PM)
P.6
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chapter
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A revision of Management
Accounting (MA) topics
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A revision of Management Accounting (MA) topics
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A revision of
Management
Accounting (MA) topics
Traditional costing
methods
Definition
Uses
Flexible
budgeting
Absorption costing
Marginal costing
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Standard costs
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Standard costing
Controllability
Performance
Management
Types of standards
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Chapter 1
Cost definitions examples
Ideal operating conditions
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Highlights cost of inefficiencies
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Attainable
standard
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Efficient operating conditions
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Includes allowance for wastage
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Ideal
standard
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Current operating conditions
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No incentive to improve efficiency
Basic
standard
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performance
management
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inventory valuation
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setting selling
prices
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budgeting
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management by
exception
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Current
standard
Uses of standard
costing
Set for the long term
Highlights changes in costs
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A revision of Management Accounting (MA) topics
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Advanced costing methods
In this chapter
Activity Based Costing (ABC).
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Target costing.
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Value analysis.
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Lifecycle costing.
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Throughput.
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Environmental cost accounting.
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Advanced costing methods
Activity Based Costing (ABC)
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Steps
1. Group production overheads into activities,
according to how they are driven.
2. Identify cost drivers for each activity.
3. Calculate an O.A.R. for each activity cost.
4. Absorb the activity costs into each
product.
5. Calculate the production cost and the
profit/(loss) if required.
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More realistic costs.
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Better insight into cost drivers, resulting in
better cost control.
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Particularly useful where overhead costs
are a significant proportion of total costs.
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The written elements of ABC are also
important. Be prepared to explain the
reasons for the development of ABC, its
advantages and disadvantages, and the
implications of ABC.
Advantages
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This is a key costing method. Comparisons
of ABC with traditional methods of overhead
absorption are particularly important.
Approach calculations by using the
methodical step by step approach.
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ABC recognises that overhead costs
are not all related to production and
sales volume.
•
ABC can be applied to all overhead
costs, not just production overheads.
•
ABC can be used just as easily in service
costing as in product costing.
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Chapter 2
It is impossible to allocate all overhead
costs to specific activities.
•
The choice of both activities and cost
drivers might be inappropriate.
•
ABC can be more complex to explain to
the stakeholders of the costing exercise.
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The benefits obtained from ABC might
not justify the costs.
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ABC will be of limited benefit if overhead
costs are primarily volume related or are
a small proportion of the total cost.
Implications
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Performance management can be
improved due to the settings of more
realistic budgets and improved cost
control.
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Criticisms of ABC
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Pricing – more realistic costs improve
cost plus pricing.
•
Sales strategy – more realistic margins
can help focus sales strategy.
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Decision making – e.g. research
and development can be directed at
products with better margins.
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Advanced costing methods
Target costing
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Estimate a market driven selling price for a new product, e.g. to
capture a required market share
Reduce this figure by the film’s required level of profit
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Produce a target cost figure for product designers to meet
Reduce costs to provide a product that meet that target cost
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Chapter 2
Implications
•
“Value analysis” looks at identifying which
product features contribute to customer
perceived value and which do not.
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Pricing – will be more realistic since
customer demand is considered.
•
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Focus is on reducing cost without
compromising perceived value.
Can labour savings be made, e.g. by
using lower skilled workers?
Cost control – target cost motivates
managers to find new ways of saving
costs.
Can productivity be improved, e.g. by
improving motivation?
•
What production volume is needed to
achieve economies of scale?
•
Could cost savings be made by
reviewing the supply chain?
•
Can any materials be eliminated, e.g. cut
down on packing materials?
•
Can a cheaper material be substituted
without affecting quality?
•
Can part-assembled components be
bought in to save on assembly time?
•
Can the incidence of the cost drivers be
reduced?
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Performance management – enhanced
because the business finds ways to
reduce costs.
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Closing the target cost gap
Value analysis
To ensure target costs can be achieved,
value analysis is used. Value Analysis
identifies any unnecessary cost elements
within the components of goods and
services.
Cost Value
Exchange Value
Use Value
Esteem Value
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Advanced costing methods
Lifecycle costing
•
A common mistake in questions is that
candidates confuse lifecycle costing with the
product lifecycle.
Is the profiling of cost over a product’s
life, including the pre-production stage.
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Tracks and accumulates the actual costs
and revenues attributable to each
product from inception to abandonment.
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Enables a product’s true profitability to
be determined at the end of its economic
life.
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Background
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Pricing decisions can be based on total
lifecycle costs rather than simply the
costs for the current period.
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Implications
Lifecycle costing
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Traditional costing systems based
around annual periods may give a
misleading impression of costs and
profitability.
The commitment of a high level of costs
at the earlier stages of the product
lifecycle (especially pre-production) has
led to the need for accounting systems
that compare revenues with all costs
incurred throughout the lifecycle.
•
Decision making – In deciding to
produce or purchase a product or
service, a timetable of life cycle costs
helps show what costs need to be
allocated to a product so that an
organization can recover its costs. If
all costs cannot be recovered, it would
not be wise to produce the product or
service.
•
Performance Management (Control)
–
Lifecycle costing thus reinforces
the importance of tight control over
locked-in costs, such as R&D in the
development stage.
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Chapter 2
Performance Management (Reporting)
Life cycle costing traces R&D,
design, production set-up, marketing
and customer service costs to
products over their entire life cycles,
to aid comparison with product
revenues generated in later periods.
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Advanced costing methods
Throughput
Multi-product decisions
Work through the methodical step by step
approach for multi product decisions.
Steps:
Application of key factor analysis to
production bottlenecks.
•
The only totally variable cost is the
purchase cost of raw materials and
components that are bought from
external suppliers.
Direct labour costs are not wholly
variable.
Criticisms
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2. For each product calculate the
throughput per unit (revenue – raw
material cost).
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1. Determine the limiting factor (bottleneck
resource).
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It concentrates on the short term. More
difficult to apply to the longer term, when
all costs are variable.
•
In the longer term as activity based
costing might be more appropriate for
measuring and controlling performance.
3. For each product calculate the
throughput per unit of the limiting factor.
4. Rank in order.
5. Production plan – using the ranking
allocate the scarce resources in the
optimum way.
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Chapter 2
The throughput accounting ratio (TPAR)
Throughput per hour of
bottleneck resource
Operating expenses
per hour of bottleneck
resource
How to improve the TPAR
Increase the sales price for each unit
sold, to increase the throughput per unit.
•
Reduce total operating expenses, to
reduce the cost per assembly hour.
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dentify the
System constraint
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Throughput
accounting ratio
Theory of constraints
Return to
step one
Elevate the
constraint
Exploit the
constraint
Subordinate
everything else
Improve productivity, reducing the time
required to make each unit of product.
Throughput accounting and the Theory of
Constraints is the subject of two technical
articles published by the examiner on the
ACCA website.
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Advanced costing methods
Environmental cost
accounting
Environmental costs
waste disposal costs
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mproved systems
External costs are imposed on
society at large but not borne by the
company that generates the cost in
the first instance
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nternal costs directly impact on the
income statement of a company
carbon emissions
usage of energy and water
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product take back costs
forest degradation
regulatory costs
health care costs
upfront costs
social welfare costs
backend costs
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Chapter 2
Environmental costs
•
•
Waste.
•
Water.
•
Energy.
The identification, collection, analysis
and use of two types of information for
internal decision making:
Monetary information on
environment-related costs, earnings
and savings.
•
Transport and travel.
•
Consumables and raw materials.
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Physical information on the use,
flows and destinies of energy, water
and materials (including wastes).
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EMA
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Advanced costing methods
Internal reporting
Categories of costs
(Hansen + Mendoza)
US EPA
Environmental
prevention co t
Conventional co t
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Potentially
hidden co t
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Environmental
detection co t
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UNDSN
Environmental
internal failure co t
Contingent
co t
Environmental
external failure co t
Image and
relation hip co t
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Co t incurred
to protect the
environment
Co t of
wa ted material
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Chapter 2
Environmental management accounting techniques
Technique
Flow co t
accounting
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Lifecycle
co ting
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nput / outflow
analysis
ABC
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Advanced costing methods
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
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OBJECTIVE CASE QUESTIONS
Gadget Co
Beckley Hill (June 2015)
Brick By Brick
Bowd
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Duff Co (June 2014)
Jola PubliShing
Chemical Free Clean Co (December 2015)
Abkaber
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Lifecycle costing
Manpac
Wargrin
Edward Co
Yam Co
Flo Pro
Environmental Management Accounting
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Cost volume profit
analysis
In this chapter
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Breakeven/CVP analysis.
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Basic breakeven chart.
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Contribution breakeven chart.
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Cost volume profit analysis
Breakeven/CVP analysis
Contribution = Sales price – Variable costs
Breakeven sales revenue =
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Fixed costs
Contribution per unit
Fixed costs
Contribution to sales ratio (or profit – volume ratio)
Output required for target profit =
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Breakeven point =
Fixed cost + Target profit
Unit contribution
Margin of safety (%) =
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Margin of safety = Budgeted level of activity – Breakeven level of activity
Budgeted level of activity – Breakeven level of activity
Budgeted level of activity
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Chapter 3
Basic breakeven chart
Breakeven analysis – break-even chart
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Breakeven
point
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Fixed Co t
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Breakeven point:
the point where
total costs = total sales
revenue
and
Where there i neither a
profit or loss
Output (unit )
The diagram is known as the break-even chart.
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Cost volume profit analysis
Contribution breakeven chart
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Breakeven
point
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Tota
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Variable
Contribution
Fixed Co t
Advantage of
thi chart:
Contribution
can be read
directly from
the chart
t
Output (unit )
The diagram is known as the contribution break-even chart
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Chapter 3
The calculation of breakeven point in a multiproduct firm follows the same pattern as in a
single product firm. While the numerator will
be the same fixed costs, the denominator
now will be the weighted average
contribution margin.
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Multi-product breakeven analysis
Weighted Average C/S ratio =
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In multi-product situations, a weighted
average C/S ratio is calculated by using the
formula:
Total Contribution
Total Revenue
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The Weighted Average C/S ratio is useful in
its own right, as it tells us what percentage
each $ of sales revenue contributes towards
fixed costs; it is also invaluable in helping us
to quickly calculate the breakeven point in
sales revenue:
Breakeven revenue =
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Fixed costs
Weighted Average C/S ratio
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Cost volume profit analysis
Step 2 : Draw the graph, showing cumulative
sales on the x-axis.
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Breakeven
point
v Sale
Revenue
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Step 3 : Draw the line that represents the
profit earned by product X.
Profit
earned
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Step 1 : Calculate the C/S ratio of each
product being sold, and rank the
products in order of profitability.
Step 4 : Draw the line that represents the
profit earned by product y, which
has a lower contribution per unit
than product X.
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Step 5 : Draw the line joining the first and
last points: it reflects the average
profitability of the three products,
and each point on that line
represents the profit earned for the
associated output, assuming that
the three products are sold in the
standard product mix, i.e. the mix
implied in the construction of the
chart.
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Chapter 3
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
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OBJECTIVE CASE QUESTIONS
Chocolates Are Forever
Beft Co
Mango Leather
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Cardio Co (December 2015)
Breakeven
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EC Ltd
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Cost volume profit analysis
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Planning with
limiting factors
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In this chapter
Limiting factor analysis.
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Linear programming.
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Planning with limiting factors
Limiting factor analysis
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A limiting factor is a factor of production that is in short supply to the extent that sales demand
cannot be met. Under these circumstances the approach is to maximise the contribution per unit of
limiting factor.
The 5-step approach:
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Step 1: Identify the limiting factor (e.g. labour, material, machine hours)
Step 2: Calculate the contribution per unit of limiting factor
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Step 3: Rank the products
Step 4: Calculate the optimum production plan
Step 5: Calculate the profit (if required)
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Chapter 4
Non-negativity “x ≥ 0, y ≥ 0”
Linear programming
4
Draw graph showing constraints and
identify the feasible region.
•
Get end-points of constraint lines –
e.g. 5x + 2y = 20 has end points
(4,0) , (0,10).
•
Decide on scale and draw lines using
end-points.
•
Feasible region is below a line if
constraint is “≤” and above the line if
“≥”.
1
Define variables
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Linear programming is used to establish
an optimum product mix when there are
two or more resource constraints. This mix
will achieve a certain (given) objective. The
objective is usually to maximise contribution,
but on occasion it is to maximise costs.
Others – e.g. “5x + 2y ≤ 20”.
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This is an important topic. The examiner
will expect a good grasp of the step by step
approach. Be ready to explain the meaning
and carry out calculations for shadow prices
and slack.
e.g. “Let x = the number of tables made
each month”.
2
Define the objective.
5
Solve the optimal production plan – draw
an example iso-contribution line by
making up a suitable value of C. Move
this out away from the origin to identify
the optimal point – it should be the last
point you get to that is still feasible.
e.g. “Maximise contribution, C = 3x + 5y”.
3
Set out constraints
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Planning with limiting factors
Determine the optimal solution exactly
by solving simultaneously the equations
of the two lines that cross at the optimal
point identified on the graph.
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Answer the question!
•
Calculate the maximum contribution /
minimum cost.
•
Write a recommendation to
management.
Note: step 5 can be replaced with the
following:
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Scale up one or both equations until
they have the same number of “y”
(or “x”).
Look at difference between the two
(adjusted) equations and solve for “x”
(or “y”, as appropriate).
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Note: if the objective is to minimise
costs, then an iso-cost line will need to
be moved towards the origin.
Substitute the value of “x” (or “y”)
back into either of the two critical
constraint equations and solve for “y”
(or “x”).
Determine the coordinates of each of
the corners of the feasible region using
simultaneous equations.
For each of the corners calculate the
contribution and select the corner with the
highest contribution.
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Chapter 4
Assumptions
Assumption
Reality
A single quantifiable objective exists e.g.
to maximise contribution.
•
Multiple objectives (e.g. risk, return).
•
Learning effects.
•
Each product always uses the same
quantity of the scarce resources per unit.
•
The selling price may have to be lowered to
sell more.
•
The contribution per unit is constant.
•
Discounts as the quantity of materials needed
increases.
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Products are independent – e.g. sell A
not B.
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•
Bo
x
•
The scenario is short term.
KAPLAN PUBLISHING
•
Economies of scale.
•
Customers may expect to buy both products
together.
•
The products may be manufactured jointly
together.
•
In the long term constraints can be changed
and fixed costs should be included.
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31
Planning with limiting factors
Slack
•
Slack is the amount by which a resource
is under utilised. It will occur when the
optimum point does not fall on the given
resource line.
Shadow (or dual) prices
32
The shadow price of a resource is
the increase in value (usually extra
contribution) that would result from
having one extra unit of a limiting
resource.
Step 1: Add one unit to the constraint
concerned, while leaving the other
critical constraint unchanged.
Step 2: solve the revised simultaneous
equations to derive a new optimal
solution.
G
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•
The simplest way to calculate shadow
prices for a critical constraint is as
follows:
Bo
x
•
It therefore represents the maximum
premium (i.e. over the normal cost) that
the firm should be willing to pay for one
extra unit of each constraint.
•
Non-critical constraints will have zero
shadow prices as slack exists already.
AC
C
A
•
Step 3: calculate the revised optimal
contribution. The increase is the
shadow price for the constraint
under consideration.
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Chapter 4
Note:
Y
4
Where a constraint is binding, obtaining
more would increase contribution.
AC
C
A
The dual price only applies as long as extra
resources improve the optimal solution
– effectively the constraint line moves
out beyond the feasible region as other
constraints become more critical.
KAPLAN PUBLISHING
D
4X + 4Y = 16,000 (labour)
000s
A
3
Bo
x
The dual price only applies as long as
extra resources improve the optimal
solution – effectively the constraint line
concerned moves out increasing the size
of the feasible region and moving the
optimal point. Eventually the constraint
line moves out beyond the feasible
region as other constraints become
critical.
2
1.5
G
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•
1
0
3X + 5Y = 15,000
(materials)
C
1
2
2.5
3
4
000s
5
X
As you buy more materials, then that
constraint relaxes and so its line on the
graph moves outwards and away from the
origin. Eventually, the materials line will be
totally outside the labour line on the graph
and the point at which this happens is the
point at which the business will cease to find
buying more materials attractive (point D on
the graph). Labour would then become the
only constraint.
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33
Planning with limiting factors
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Beft Co
Cosmetics Co (December 2010)
Cut and Stitch (June 2010)
AC
C
A
G
lo
ba
l
Tablet Co (June 2014)
34
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chapter
Bo
x
5
G
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Pricing
In this chapter
Factors to consider when pricing (The 3 C’s).
•
Calculation aspects.
•
Pricing approaches.
AC
C
A
•
•
Marketing-based approaches.
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35
Pricing
•
Costs
Calculation aspects
•
Need to cover costs to make a profit.
Price elasticity of demand (PED)
•
May need to consider whole product
portfolio (e.g. some products may be loss
leaders).
•
In the short term, may be happy just
to cover variable costs to make some
contribution.
May need to consider whole lifecycle.
Pricing approaches
PED = % change in demand / % change
in price.
•
PED >1 (elastic)
the price is cut.
•
PED <1 (inelastic)
revenue increases
if the price is raised.
revenue increases if
Demand-based approach
•
We need to be competitive.
Algebraic approach
•
How close a substitute are competitors’
products?
•
Profit maximised when MR = MC
•
MR = a – 2bQ
•
P = a – bQ
•
‘a’ is the price at which demand falls to 0
•
‘b’ = gradient = Change in price / Change
in demand.
Customers
•
36
•
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Competitors
AC
C
A
•
Consider power of customers to go
elsewhere; pressurise you to drop prices.
Bo
x
Factors to consider when
pricing (The 3 C’s)
How much are they willing to pay? (Need
to do market research).
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Chapter 5
Tabular approach
$
$
$
$
$
$
22
20
19
18
17
15
6
Contribution per unit
16
Number of units sold
Total Contribution, in $000
Net Profit in $000
Cost plus pricing
6
6
6
6
13
12
11
9
50,000
60,000
70,000
80,000
90,000
90,000
800
840
910
960
990
810
200
200
280
280
360
360
600
640
630
680
630
450
AC
C
A
Less Fixed costs, in $000
6
14
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Variable cost per unit
Bo
x
Price per unit
•
Establish cost per unit – options include MC, full cost, prime cost.
•
Calculate price using target mark-up or margin.
•
Often used as a starting point even when using other methods.
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Pricing
Disadvantages
Widely used and accepted.
•
Ignores the economic relationship
between price and demand.
•
Simple to calculate if costs are known.
•
No attempt to establish optimum price.
•
Selling price decision may be
delegated to junior management.
•
•
Justification for price increases.
Bo
x
Advantages
•
•
May encourage price stability – if all
competitors have similar cost
structures and use similar mark-up.
•
Does not guarantee profit – if sales
volumes are low fixed costs may not
be recovered.
•
Must decide whether to use full cost,
manufacturing cost or marginal cost.
•
This structured method fails to
recognise the manager’s need for
flexibility in pricing.
•
Circular reasoning – price changes
affect volume which affect unit fixed
costs which affect price.
G
lo
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AC
C
A
38
Different absorption methods give
rise to different costs and hence
different selling prices.
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Chapter 5
Marketing-based approaches
•
Set a high initial price to ‘skim off’
customers who are willing to pay extra.
Prices fall over time.
Suitability
Suitability
•
If a firm wishes to increase market share.
•
If the firm wishes to discourage new
entrants from entering the market.
G
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•
Little effective competition (e.g. where
the product is new and different or where
barriers to entry deter competition).
A firm with liquidity problems may use
market skimming to generate high cash
flows early on.
AC
C
A
•
Set a low initial price to gain market
share. If a high volume is achieved, the
low price could be sustainable.
Bo
x
Price skimming
•
Penetration pricing
•
Where high prices in the early stages of
a product’s life might generate high initial
cash flows.
•
Where products have a short life cycle.
•
If the firm wishes to shorten the initial
period of the product’s life cycle.
•
If there are significant economies of scale
to be achieved from high-volume output.
•
Demand is highly elastic and so would
respond well to low prices.
Linking pricing decisions for different
products
•
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Basic idea: product A is cheap to attract
customers who then also buy the higher
margin product B.
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39
Pricing
•
Key issue is the extent to which
customer must buy the other products.
Price discrimination
•
Suitability
Complementary products.
•
Product line pricing.
Suitability
Bo
x
•
•
Discount for individual large order.
•
Cumulative quantity discounts.
Suitability
•
The seller has some degree of monopoly
power.
•
Customers can be segregated into
different markets.
G
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Volume discounts
40
Have different prices in different markets
for the same product.
To increase customer loyalty.
•
To attract new customers.
•
To reduce sales processing costs.
•
To Lower customer’s purchasing costs.
•
Clearance of surplus stock.
•
Increased use of off peak capacity.
AC
C
A
•
•
Barriers exist (or can be created) to
prevent transfer between markets.
•
Different elasticity in each market (set
higher prices in the more inelastic
segment).
Relevant cost pricing
•
Price = net incremental cash flow.
Suitability
•
One-off projects.
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Chapter 5
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
ALG Co (June 2015)
Stay Clean (December 2009)
AC
C
A
G
lo
ba
l
MKL
KAPLAN PUBLISHING
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41
AC
C
A
G
lo
ba
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Bo
x
Pricing
42
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G
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Relevant costing
In this chapter
•
Relevant costing principles.
•
Make v buy decisions.
•
Shut down decisions.
AC
C
A
6
Bo
x
chapter
•
Joint products – the further
processing decision.
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43
Relevant costing
Relevant costing principles
Include future incremental cash flows
arising as a direct result of the decision.
Ca h
44
• Depreciation.
• Sunk costs.
• Incremental
fixed overheads
– look at whole
organisation.
• Unavoidable
costs.
• Apportioned
fixed overheads.
•
Financing
cash flows
(e.g. interest).
AC
C
A
•
Exclude
• Opportunity costs
– look at the next
best alternative
use of an asset
foregone.
G
lo
ba
l
In addition to the calculations, be prepared to
explain the qualitative factors involved in the
decision making process.
Include
• Incremental costs.
Bo
x
A common mistake in the exam is that
candidates include irrelevant costs, e.g.
sunk costs in their decision. Ensure that you
understand the meaning of a ‘relevant cash
flow’.
Future
Incremental
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Chapter 6
Decision
•
Look at future incremental cash flows.
•
Watch out for opportunity costs –
especially whether or not spare capacity
exists and alternative uses for capacity.
•
Customer perception – customers may
value products being made in-house.
•
Confidentiality – buying in gives other
companies some information about how
the product is made.
Bo
x
Make v buy decisions
Shut down decisions
G
lo
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Decision
Practical factors
•
Look at future incremental cash flows.
•
Apportioned overheads not relevant –
only include specific incremental costs.
•
Control of quality and delivery.
•
•
The external supplier may possess
specialist skills.
Closure costs – e.g. penalties,
redundancies.
•
Reorganisation costs.
Alternative uses for resources – e.g.
make an alternative product?
AC
C
A
Can the external supplier deliver sufficient
quantity and quality as and when
needed?
•
•
Social factors, e.g. outsourcing may result
in redundancies.
•
•
Legal factors, e.g. outsourcing may
impact contractual obligations.
Practical factors
•
Alternative use of resources.
KAPLAN PUBLISHING
•
There may be additional costs,
e.g. reorganisation costs which are
unquantifiable at present.
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45
•
Impact on customers – e.g. expect a
wide portfolio of products.
•
Impact on other products – e.g. may be a
loss leader.
Decision
G
lo
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Joint products – the further
processing decision
Bo
x
Relevant costing
Look at future incremental cash flows:
sell at split off v process further and
then sell.
•
Pre-separation (“joint”) costs not relevant
– only include post split-off aspects.
AC
C
A
•
46
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Chapter 6
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Hi Life Co (December 2014)
Bits and Pieces (June 2009)
SIP Co
Stay Clean (December 2009)
AC
C
A
G
lo
ba
l
Choice of contracts
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AC
C
A
G
lo
ba
l
Bo
x
Relevant costing
48
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chapter
Bo
x
7
Risk and uncertainty
G
lo
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In this chapter
Basic concepts.
•
Research techniques.
•
Simulation.
•
Expected values.
•
Sensitivity.
•
Payoff tables.
•
Decision trees.
AC
C
A
•
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49
Risk and uncertainty
Basic concepts
50
All businesses face risk.
•
Risk = variability in future returns.
•
Some writers distinguish between “risk”
and “uncertainty”:
There are a number of methods available
to manage risk:
–
research techniques
–
simulation
–
expected values
–
sensitivity analysis
–
maximax, maximin, minimax
regret.
G
lo
ba
l
•
•
Bo
x
Be prepared to discuss all of the techniques
available for managing risk and to carry out
relevant calculations.
“risk” is used where it is possible to
assign probabilities to the different
possible outcomes
–
“uncertainty” is used where this is not
possible.
AC
C
A
–
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Chapter 7
Simulation
•
Desk research
1
•
Information is collected from secondary
sources, e.g. press articles.
Apply probabilities to key factors in
scenario analysis.
2
•
It is cheap and quick.
•
However, it may not be accurate, up to
date or relevant.
Use random numbers to select a
particular scenario and calculate
outcome.
3
Repeat until build up a picture of possible
outcomes (i.e. a probability distribution).
G
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Field Research
Bo
x
Research techniques
4
•
Information is collected from primary
sources
•
Two sub-types:
Motivational research which is used
to understand what factors motivate
consumers to buy/not buy a product.
–
Measurement research which is
used to quantify these factors, e.g.
questionnaires.
AC
C
A
–
Make decision based on attitude to risk.
Focus Groups
•
Involves a small group discussion, e.g.
regarding a new product.
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Risk and uncertainty
•
EV = ∑ outcome × probability.
•
Make decision based on best EV.
•
Calculations are relatively simple.
•
Takes risk into account.
•
Information is reduced to a single number
resulting in easier decisions.
Disadvantages
Advantages
The probabilities used are usually very
subjective.
G
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•
AC
C
A
52
Bo
x
Expected values
•
The EV is the average payoff if the
project is repeated many times. Not
useful for one-off decisions.
•
The EV gives no indication of the
dispersion of possible outcomes about
the expected value. The dispersion gives
information about the risk.
•
The EV may not correspond to any of the
actual outcomes.
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Chapter 7
2
Maximax
•
Identify key variables by calculating how
much an estimate can change before the
decision reverses.
•
The “optimist” chooses the decision with
most attractive upside potential.
3
Maximin
•
Can only vary one estimate at a time.
The “pessimist” limits the downside
potential by choosing the decision with
the most attractive “worse-case scenario”.
Prepare table of profits based on different
decision choices and different possible
scenarios.
4
Minimax regret
•
Prepare a regret table.
•
Four different ways of making a decision.
•
1
Expected values
For each possible cell in the table, regret
= actual profit compared with possible
profit if had made the best decision.
•
EV approach chooses the decision that
gives the highest EV. Of these four
methods, it is the only one to take the
probabilities of the different outcomes into
account.
•
The “sore loser” chooses the decision
that minimises their maximum possible
regret.
KAPLAN PUBLISHING
AC
C
A
•
•
G
lo
ba
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Payoff tables
Bo
x
Sensitivity
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Risk and uncertainty
A decision tree is a diagrammatic
representation of a multi-decision problem,
where all possible courses of action are
represented, and every possible outcome of
each course of action is shown.
AC
C
A
G
lo
ba
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Decision trees should be used where a
problem involves a series of decisions being
made and several outcomes arise during
the decision-making process. Decision
trees force the decision maker to consider
the logical sequence of events. A complex
problem is broken down into smaller, easier
to handle sections.
The financial outcomes and probabilities are
shown separately, and the decision tree is
‘rolled back’ by calculating expected values
and making decisions.
Label the tree and relevant cash
inflows/outflows and probabilities
associated with outcomes.
Step 2: Evaluate the tree from right to left
carrying out these two actions:
(a) Calculate an EV at each
outcome point.
(b) Choose the best option at each
decision point.
Three step method
Step 1: Draw the tree from left to right,
showing appropriate decisions and
events / outcomes.
54
Some common symbols can be
used: a square is used to represent
a decision point (i.e. where a choice
between different courses of action
must be taken. A circle is used
to represent a chance point. The
branches coming away from a circle
with have probabilities attached to
them. All probabilities should add up
to ‘1’.
Bo
x
Decision trees
Step 3: Recommend a course of action to
management.
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Chapter 7
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Recyc
Dowb Co
Amelie
AC
C
A
G
lo
ba
l
Gam Co (June 2014)
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AC
C
A
G
lo
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Bo
x
Risk and uncertainty
56
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Budgeting
G
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In this chapter
•
The purposes of budgets.
•
Behavioural aspects of budgeting.
•
Conflicting objectives.
•
Participation – top down v bottom up.
AC
C
A
8
Bo
x
chapter
•
Incremental budgeting.
•
Zero based budgeting.
•
Rolling budgets.
•
Activity based budgeting/costing.
•
Feed forward control.
•
Selecting a budgetary system.
•
Incorporating risk and uncertainty.
•
Beyond budgeting.
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57
Budgeting
•
The purpose of budgets
Forecasting
•
Planning
•
Control
•
Communication
•
Co-ordination
•
Evaluation
•
Motivation
•
Authorisation
•
G
lo
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•
Operational planning is very short term,
very detailed and is mainly concerned
with control. Most budgeting activities fall
within operational planning and control.
Bo
x
Aims
Delegation.
Budgetary / Tactical
Towards achieving strategic plans
58
AC
C
A
The Performance Hierarchy
•
Strategic planning is long term, looks at
the whole organisation and defines
resource requirements.
•
Tactical planning is medium term, looks at
the department / divisional level and
specifies how to use resources.
Strategic
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Operational
Day to day plans
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Chapter 8
Behavioural aspects of
budgeting
•
•
Dysfunctional behaviour – want goal
congruence.
•
Budgetary slack.
Bo
x
Key issues
For motivation purposes, an aspirations
target should be set slightly above the
anticipated performance level.
G
lo
ba
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•
Management styles (Hopwood)
An aspirations budget is a budget set at
a level which exceeds the current level
achieved. This will motivate managers to
improve if it is seen as attainable but may
always result in an adverse variance if
it is too difficult to achieve. This must be
managed carefully.
Budget constrained – short-term pressure
to hit budget.
•
Profit conscious – emphasis on longer
term company-wide performance.
•
Non-accounting – emphasis on non
financial aspects.
AC
C
A
•
Target setting and motivation
•
An expectations budget is a budget set
at current achievable levels. This is
unlikely to motivate managers to improve
but may give more accurate forecasts for
resource planning.
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59
Budgeting
Be prepared to discuss the appropriateness
of the different types of budgeting and
to evaluate the pros and cons of each
budgeting technique.
Conflicting objectives
Company v division (see later).
•
Division v division.
•
Short-termism.
•
Individualism.
AC
C
A
G
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Bo
x
•
60
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Chapter 8
Participation – top-down v bottom up
Advantages of participative budgets
Disadvantages of participative budgets
•
Increased motivation.
•
•
Should contain better information,
especially in a fast-moving or diverse
business.
•
•
Better communication.
•
Senior managers can concentrate on
strategy.
AC
C
A
KAPLAN PUBLISHING
•
Bo
x
Increases managers’ understanding
and commitment.
Bad decisions from inexperienced
managers.
Budgets may not be in line with
corporate objectives (dysfunctional
behaviour).
G
lo
ba
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•
Senior managers may resent loss of
control.
•
Budget preparation is slower and disputes
can arise.
•
Figures may be subject to bias if junior
managers either try to impress or set
easily achievable targets (budgetary
slack).
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Budgeting
Start with the previous period’s budget
or actual results and add (or subtract)
an incremental amount to cover inflation
and other known changes.
•
Suitable for stable businesses
where costs are not expected to change
significantly. There should be good cost
control and limited discretionary costs.
Advantages
62
G
lo
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•
Bo
x
Incremental budgeting
Disadvantages
Quickest and easiest method.
•
Assuming that the historic figures are
acceptable, only the increment needs
to be justified.
AC
C
A
•
•
Builds in previous problems and
inefficiencies.
•
Uneconomic activities may be continued.
•
Managers may spend unnecessarily to
ensure they get the same (or a larger)
budget next year.
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Chapter 8
•
Preparing a budget from a zero base,
as though there is no expectation of
current activities to continue from one
period to the next, and justifying every
piece of expenditure.
Identify all possible services (and
levels of service) and then cost each
service or level of service; these
are known individually as decision
packages.
2
Rank the decision packages in order
of importance.
3
Identify the level of funding that will
be allocated to the department.
4
Use up the funds in order of the
ranking until exhausted.
G
lo
ba
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1
AC
C
A
•
Bo
x
Zero based budgeting
Used for allocating resources
when spend is discretionary (e.g.
service industry) or in public sector
organisations.
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Budgeting
Disadvantages
•
Eliminates past errors that may be
perpetuated in an incremental analysis.
•
Emphasises short term benefits to the
detriment of long term goals.
•
A considered allocation of resources.
•
•
Leads to increased staff involvement.
Budgeting can be too rigid and
opportunities may not be embraced.
•
Responds to changes in the business
environment.
•
Knowledge and understanding of
the cost behaviour patterns of the
organisation will be enhanced.
•
Bo
x
Advantages
Management skills required may not be
present.
Managers may feel demotivated due to
the time consuming process.
•
Ranking activities difficult.
AC
C
A
G
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•
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Chapter 8
Rolling budgets
A budget kept continuously up to date by
adding another accounting period
(eg month or quarter) when the earliest
accounting period has expired.
•
Aim: to keep tight control and always
have an accurate budget for the next 12
months.
•
Suitable if accurate forecasts cannot be
made, or for any area of business that
needs tight control.
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Exam focus
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Budgeting
Activity based budgeting/
costing
Use ABC for budgeting purposes:
Step 1 Identify cost pools and cost
drivers.
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Step 2 Calculate a budgeted cost driver
rate based on budgeted cost and
budgeted activity.
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AC
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Step 3 Produce a budget for each
department or product by
multiplying the budgeted cost
driver rate by the expected
usage.
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Chapter 8
Disadvantages
•
Greater focus on understanding
overheads.
•
Extra time and effort to establish an
ABB system.
•
Greater control of overheads.
•
•
Can be useful in a TQM environment,
relating costs to quality.
Problems linking ABB activities to
established responsibility centres.
•
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Advantages
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In the short term many overheads are
not controllable and do not vary directly
with changes in the volume of activity
for the cost driver.
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Budgeting
Feed forward control
Feed-forward control is defined as the ‘forecasting of differences between actual and planned
outcomes and the implementation of actions before the event, to avoid such differences.
•
In simpler terms, feedforward control is where a problem is identified and corrective action
taken, before the problem occurs
•
An example would be using a cash-flow budget to forecast a funding problem and as a result
arranging a higher overdraft well in advance of the problem.
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•
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Disadvantages
•
It encourages managers to be pro
active and deal with problems before
they occur.
•
It may be time consuming as control
reports must be produced regularly.
•
•
Re-forecasting on a monthly or
continuous basis can save time when it
comes to completing a quarterly or
annual budget.
It may require a sophisticated
forecasting system, which might be
expensive.
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Advantages
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Chapter 8
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Budgeting
new statistical models and sources
of information suitable for the new
budgetary system.
Selecting a budgetary
system
Determinants
–
•
Type of organisation.
•
Type of industry.
•
Type of product and product range.
•
Culture of the organisation.
Are suitably trained staff are available to
implement the change successfully?
•
Will changing the system take up
management time which should be
focusing on production or sales?
•
All staff involved in the budgetary
process will need to be trained.
•
Rolling budgets.
•
Simulation.
•
Sensitivity analysis.
AC
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•
Cost v benefits for the new system:
–
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Incorporating risk and
uncertainty
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Factors to consider when changing a
budgetary system
•
Benefits may be difficult to quantify.
As a result organisations may (often!)
persevere with a sub-optimal system.
Bo
x
•
Costs include new system costs,
training, downtime of existing staff,
consultancy fees and development of
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Chapter 8
Using Spreadsheets
Advantages
Disadvantages
•
Can accommodate very complex models.
•
•
Formulae can be used so that if any
figure is amended, all the figures will be
immediately recalculated.
•
The results can be printed out or
distributed to other users electronically,
quickly and easily.
•
Errors in design, particularly in the use of
formulae, can produce invalid output.
•
Over-reliance on results.
•
Security issues.
Most programs can also represent the
results graphically.
Bo
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C
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•
Data can be accidentally changed (or
deleted) without the user being aware of
this occurring.
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•
Spreadsheets for a particular budgeting
application will take time develop.
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Budgeting
Beyond budgeting
Incremental targets
Fixed incentives
Planning & controls
Fixed annual plans
Variance controls
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Targets & rewards
72
Beyond Budgeting
Management Model
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Traditional Budgeting
Management Model
Stretch goals
Relative targets & rewards
Continuous planning
KPI’s & rolling forecasts
Resource & coordination
Pre-allocated resources
Central co-ordination
Resources on demand
Dynamic coordination
Organisational culture
Central control
Focus on managing numbers
Local control of goals/plans
Focus on value creation
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Chapter 8
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Effective budgeting
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NN
AC
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Zero-based budgeting
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Budgeting
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Quantitative analysis
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In this chapter
•
High-low.
•
Learning curves.
AC
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9
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chapter
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Quantitative analysis
•
High-low
Used to determine a linear relationship
between two variables – usually to split
costs into fixed and variable elements.
Cost
X
X
Step 4: Use the variable and fixed cost to
forecast the total cost for a specified level
of activity.
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X
Fixed cost = Total cost at activity level –
Total variable cost.
•
Scatter diagram
X
Step 3: Find the fixed cost, using either
the high or low activity level.
Bo
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•
X
AC
C
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Output
•
Step 1: Select the highest and lowest
activity levels, and their costs.
•
Step 2: Find the variable cost/unit.
Cost at high level activity – Cost
at low level activity
Variable
=
cost/unit
High level of activity – Low level
of activity
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Chapter 9
Learning curves
y = axb
where y = average time (or average
cost) per unit or per batch
a = time (or cost) for first unit
or per batch
log r
(r = rate of learning)
b=
log 2
Mechanics
As cumulative output doubles, the
cumulative average time per unit falls to
a fixed % (the learning rate) of the
previous average.
AC
C
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•
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This is an important topic. The technique
is similar for all questions and therefore
practice is the key to scoring a good mark.
Be prepared to discuss the implications of
the learning curve effect and the conditions
required for the learning effect to apply.
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x
Exam focus
•
x = cumulative output in units
or in batches
Key issue is to see units as part of the
history of production (e.g. units have
serial numbers).
E.g. time to make 20th item = total time
to make first 20 units – time to make first
19 units.
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Quantitative analysis
Conditions for the learning effect to apply:
The activity is labour intensive and
relatively complex so that learning can
occur.
•
A repetitive process for each unit.
•
The product is new.
•
The product is complex.
•
Early stages of production.
•
No prolonged breaks in production.
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•
Cessation of the learning effect (steady
state):
78
Machine efficiency restricts further
improvements.
•
‘Go slow’ agreements.
AC
C
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•
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Chapter 9
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Big cheese chairs (December 09)
Zost Co
Henry Company (December 09)
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BokCo (June 2015)
AC
C
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Sciento
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AC
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Quantitative analysis
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chapter
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10
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Advanced variances
In this chapter
Sales variances.
•
Materials mix and yield variances.
•
Other targets for controlling production
processes.
AC
C
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•
•
Planning and operational variances.
•
Modern manufacturing environments.
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Advanced variances
Total sales variance
Did each unit
sell for more or
less than the
budgeted selling
price?
•
Actual Quantity
Sold x Standard Price
(AQ SP)
Actual Quantity
(AQ SM)
Sold x Standard Margin
Budget Quantity x
Standard Margin
Did the
organisation sell
more or less
units than was
budgeted?
(BQ SM)
Price
Variance
Volume
Variance
Note: ‘Margin’ = contribution per unit
(marginal costing) or profit per unit
(absorption costing).
AC
C
A
•
Sales volume
variance
(AQ AP)
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Sales price variance
Actual Quantity
Sold x Actual Price
Bo
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Sales variances
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Chapter 10
Materials mix and yield
variances
Mix and Yield variances are examined very
frequently. It may help to use a tabular
approach when calculating these variances.
Basic idea
Material yield
variance
Only use where materials can be
substituted for each other.
•
Still do separate price variances for each
material.
•
Mix and yield are instead of separate
usage variances.
AC
C
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•
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Material mix
variance
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Be prepared to explain the meaning of each
variance and the possible causes of the
variances calculated.
Bo
x
Material u age
variance
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Advanced variances
Calculations
in actual mix
@standard prices
X
Actual total Q input
in standard mix
@standard prices
X
Standard total Q input
(for actual output)
in standard mix
@standard prices
X
Yield Variance
Standard Mix
Actual Mix
Difference
@ standard
price
Variance
A
X
X
X
$X
$X
X
X
$X
X
X
AC
C
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X
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Material
B
84
Mix Variance
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Actual total Q input
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Chapter 10
Mix – A favourable variance would suggest
that a higher proportion of a cheaper material
was used. This could be due to:
A decision to cut costs.
•
Greater availability of cheaper materials.
•
Unavailability of other (more expensive)
materials.
•
Costs of other materials having risen so it
was decided to use less of them.
•
Quality measures, e.g. % waste, % yield.
•
Average cost of inputs.
•
Average cost of output.
•
Average prices achieved for finished
products.
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•
Other targets for controlling
production processes
Bo
x
Possible reasons
AC
C
A
Yield – An adverse variance would suggest
that less output has been achieved for
a given input, i.e. that the total input in
volume is more than expected for the output
achieved. This could be due to:
•
labour inefficiencies
•
higher waste
•
inferior materials
•
using a cheaper mix with a lower yield.
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•
Average margins.
•
% on-time deliveries.
•
Customer satisfaction ratings.
•
Detailed timesheets.
•
% idle time.
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Advanced variances
Planning and operational
variances
Original budget
(ex-ante)
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It is important to be able to calculate the
variances but it is equally as important to be
able to interpret each variance and discuss
the reasons why a standard should be
revised.
Bo
x
Exam focus
Revised budget
(ex-post)
AC
C
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Planning variances
(uncontrollable?)
Operating variances
Controllable?)
Actual results
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Chapter 10
Disadvantages
Advantages
Variances are more relevant.
•
•
The operational variances give a ‘fair’
reflection of the actual results achieved
in the actual conditions.
The establishment of ex-post budgets
is very difficult.
•
Managers whose performance is
reported to be poor using such a
budget are unlikely to accept them.
Bo
x
•
•
Managers are more likely to accept
and be motivated by the variances.
•
It emphasises the importance of
planning.
•
The analysis tends to exaggerate the
interrelationship of variances.
•
The analysis helps in the standard
setting learning process.
•
Poor performance is often excused as
being the fault of a badly set budget.
•
Frequent demands for revisions may
result in bias.
Extra administration.
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87
Advanced variances
A change in one of the main materials
used to make a product.
•
An unexpected increase in the price of
materials due to a rapid increase in world
market prices (e.g. the price of oil or
other commodities).
•
A change in working methods that alters
the expected direct labour time for a
product or service.
•
An unexpected change in the rate of pay
to the workforce.
AC
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•
Bo
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Good reasons to revise standards
Market size and market shares variances
•
Split the sales volume variance into two
elements.
Original budget sales
x standard margin
Revised budget sales
x standard margin
(to achieve target share of actual market
Actual sales quantity x
88
standard margin
}
}
Market size variance (planning)
Market share variance (operational)
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Chapter 10
•
When applying planning and operating
principles to cost variances, care must
be taken over volumes and flexing the
budgets.
The examiner’s approved approach for
use in the exam is to flex both the original
and revised budgets to actual production
levels.
•
For operational variances, the revised
standards and flexed budget supersede
the original standards.
AC
C
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Original budget
(flexed)
Total Quality Management (TQM)
TQM is the continuous improvement in
quality, productivity and effectiveness through
a management approach focusing on both
process and the product.
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•
Modern manufacturing
environments
Bo
x
Planning and operating cost variances
Fundamental features include:
•
recognition that quality is determined by
customer requirements
•
prevention of errors before they occur
•
importance of total quality in the design of
systems and products
•
real participation of all employees
•
commitment of senior management to
the cause
•
recognition of the need for continual
improvement.
Planning variances
Revised budget
(flexed)
Operating variances
Actual results
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Advanced variances
Just-in–time (JiT)
Relevance of variance analysis
JIT is a pull-based system of planning and
control.
•
Pulling work through the system in
response to customer demand.
•
Goods are only produced when they are
needed.
•
•
This eliminates large inventories of
materials and finished goods.
•
It is doubtful whether standard costing is
of much value in automated
manufacturing environments.
•
Standard costing and adherence to
a preset standard is inconsistent with the
concept of continuous improvement.
•
Ideal standards are often used therefore,
adverse variances have a different
meaning than if a current standard was
used.
•
Variance analysis is often carried out
on an aggregate basis (total material
usage variance, total labour efficiency
variance and so on) but in a complex and
Bo
x
•
Standard costs become outdated quickly
in a modern business environment.
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Key characteristics for successfully operating
such a system are:
90
Standard product costs apply to
manufacturing environments in which
identical products are made. They are not
suitable where products are customised
to customer specifications.
High quality – possibly through deploying
TQM systems.
•
Speed: rapid throughput to meet
customers’ needs.
•
Reliability: computer-aided manufacturing
technology will assist.
•
Flexibility: small batch sizes and
automated techniques are used.
•
Low costs: through all of the above.
AC
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•
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Chapter 10
Variance analysis control reports tend to
be made available to managers at the
end of a reporting period. In the modern
business environment managers need
more ‘real time’ information about events
as they occur.
AC
C
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•
Bo
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constantly changing business
environment more detailed information is
required for effective management
control.
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Advanced variances
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Perseus Co – Revision of basic variances
OBC (December 2015)
Safe Soap Co (December 14)
AC
C
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BokCo (June 2015)
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chapter
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11
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Performance measurement
and control
In this chapter
Overview.
•
Ratio analysis.
AC
C
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•
•
Non-financial performance indicators.
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Performance measurement and control
Overview
Ratio analysis
Preliminaries
A key topic. Tested in detail in all exams to
date.
An effective system of performance
measurement is critical if investments /
divisions / managers are to be controlled.
94
•
Ratios may not be representative of the
position throughout a period.
E.g. seasonal trade.
Bo
x
Exam focus
•
Need a basis for comparison.
Budgets, for control purposes.
–
Last year’s figures to identify trends.
•
profit, revenue, margins
–
•
share price if listed
Competitors’ results and/or industry
averages to assess performance.
•
ratio analysis
•
ROI, RI for divisions
•
variances
•
non-financial measures (very important!).
AC
C
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–
Typical measures include the following:
•
Ratios can be manipulated by
management. E.g. “window dressing”.
•
Ratios indicate areas for further
investigation rather than giving answers.
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Chapter 11
Profitability ratios
Net Profit
ROCE =
•
Gross margin =
•
Net margin =
•
Asset turnover =
Sales
Sales
x 100%
x 100%
Sales
Capital
Employed
Payables
Payables
=
x 365
days
Credit purchases
•
Inventory
Inventory
=
x 365
days
Cost of sales
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Net profit
•
x 100%
Capital Employed
Gross profit
Receivables
Receivables
=
x 365
days
Credit sales
Bo
x
•
•
AC
C
A
ROCE = net margin x asset turnover
Measuring risk
•
Financial Gearing =
Liquidity / working capital ratios
•
•
Current Ratio =
Quick Ratio
=
(acid test)
KAPLAN PUBLISHING
or
=
Dividend Cover
=
Current Assets
Current Liabilities
•
Current Assets minus
inventory
Current liabilities
•
Interest Cover
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=
Debt
Equity
Debt
Debt + Equity
Net Profit
Total Dividend
Operating Profit
Interest
95
Performance measurement and control
Exam focus
96
•
Different stakeholders will have different
objectives. Companies may deal with this
by having a range of performance
measures.
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The examiner has stated that candidates
must understand that a balance is needed
between financial and non-financial
performance indicators. A seemingly
reasonable financial result can hide much
deeper problems which, if left unchecked, can
result in financial disaster.
Stakeholders
Bo
x
Non-financial performance
indicators
Financial performance appraisal often
reveals the ultimate effects of operational
factors and decisions but non-financial
indicators are needed to monitor causes.
•
The achievement of these goals is
monitored using a number of measures,
many of which are non-financial.
•
A firm’s success usually involves
focussing on a small number of goals
where they must win.
AC
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•
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Chapter 11
The balanced scorecard
(Kaplan and Norton)
Financial perspective
Bo
x
How do we look to
hareholder and lender ?
Customer perspective
ee u ?
nnovation and learning
Can we continue to improve
and create value?
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How do cu tomer
V S ON AND STRATEGY
nternal business
processes
AC
C
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What mu t we excel at?
Benefits of the balanced scorecard
Problems with the balanced scorecard
•
It makes use of external as well as internal
information.
•
Selection of measures.
•
Obtaining information.
It focuses on factors, including non financial
ones, which will enable a company to succeed.
•
Information overload.
•
Conflict between measures.
•
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Performance measurement and control
The building block model (Fitzgerald et al)
•
Dimensions
•
Financial performance.
Rewards
•
Competitive performance.
•
•
Quality.
•
Flexibility.
•
Resource utilisation.
•
Innovation
Ownership
•
•
Achievability •
•
Equity
•
Dimensions
Clarity
Motivation
Bo
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Rewards
•
To ensure that employees are motivated
to meet standards, targets need to be
clear and linked to controllable factors.
AC
C
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Standards
•
To ensure success it is vital that
employees view standards as achievable,
fair and take ownership of them.
Controllability
Sources of goals.
Standards
•
98
Measures.
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Chapter 11
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Grate Co
CIM (December 2015)
Y and Z
AC
C
A
G
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Jamair (December 2014)
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AC
C
A
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Performance measurement and control
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chapter
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12
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ransfer pricing and divisional
performance measurements
In this chapter
Transfer pricing.
•
Divisional performance measurement.
AC
C
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•
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Transfer pricing and divisional performance measurements
Transfer pricing
Rules
Objectives
Goal congruence – divisional decisions
are the correct decisions for the group.
•
Performance measurement.
•
Autonomy.
•
Minimising global tax liability.
•
To record the movement of goods
and services.
•
If spare capacity exists,
TP = marginal cost.
With production constraints,
TP = marginal cost + opportunity cost of
not using those resources elsewhere.
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Practical transfer pricing systems
Market price
Exam questions
AC
C
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Will often be given a TP and asked to
comment. Look at the following.
102
In a perfectly competitive market,
TP = market price.
Bo
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•
•
•
Will be seen as fair by managers.
•
Does an external market exist for the
component?
•
Implications for divisional performance –
e.g. is a target ROI achieved?
•
Prices may be linked to volume, so which
to use?
•
Resulting manager behaviour – does it
give dysfunctional decision making
– e.g. will a manager reject a new
product that is acceptable to the company
as a whole?
•
May be more than one market price –
which to use?
•
Are costs of selling externally the same
as for internal transfers?
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Chapter 12
Divisional performance
measurement
•
Marginal or full cost?
•
Full cost can cause problems as TP
viewed as a variable cost by the receiving
division.
Standard cost aids responsibility
accounting.
Negotiation
Manager or division?
•
Type of division.
Look at bargaining power of different
parties.
AC
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Key considerations
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Production cost + mark-up
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Transfer pricing and divisional performance measurements
Type of division
Description
Typical measures
Cost centre
•
•
Total cost and cost per unit.
•
Cost variances.
•
NFPIs related to quality,
productivity and efficiency.
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Division incurs costs but has no
revenue stream.
Investment
centre
104
Division has costs and revenue.
All of the above PLUS
Manager does not have the
authority to alter the level of
investment in the division.
•
Total sales and market share.
•
Profit.
•
Sales variances.
•
Working capital ratios (depending
on the division concerned).
•
NFPIs e.g. related to productivity,
quality and customer satisfaction.
•
•
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Profit Centre
Division has costs and revenue.
All of the above PLUS
Manager does have the
authority to invest in new assets
or dispose of existing ones.
•
ROI.
•
RI.
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Return on Investment (ROI)
Exam focus
ROI =
•
•
Advantages of ROI
Relative measure (%), therefore aids
comparisons between divisions of
different sizes.
Used externally (ROCE) and therefore
understood by users.
Encourages good use of existing
capital resources.
It can be broken down into secondary
ratios for more detailed analysis.
•
•
•
•
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Disadvantages of ROI
May lead to dysfunctional decision
making e.g. a division with a current
ROI of 30% would not wish to accept
a project offering an ROI of 25% as
this would dilute its current figure.
ROI increases as assets get older if
NBVs are used, thus giving managers
an incentive to hang on to possibly
inefficient obsolete machines.
It may encourage the manipulation of
profit and capital employed.
Different accounting policies can
confuse comparisons.
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Controllable capital employed
AC
C
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•
Pre tax controllable profit
Bo
x
An understanding of the drawbacks of ROI is essential for the exam.
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Transfer pricing and divisional performance measurements
Residual Income (RI)
RI = Pre tax controllable profits – imputed charge for controllable invested capital
Advantages of RI
•
Does not facilitate comparisons
between divisions of different sizes.
Bo
x
•
Profit and capital employed may be
subject to manipulation.
Cost of financing a division is brought
home to divisional managers.
AC
C
A
•
Disadvantages of RI
Reduces the problem of rejecting
projects with ROIs greater than the
group target but less than the division’s
current ROI.
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Chapter 12
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
Transfer Pricing
Hammer (June 10)
AC
C
A
G
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Rotech (June 2014)
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AC
C
A
G
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Bo
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Transfer pricing and divisional performance measurements
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chapter
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Performance measurement in
not-for-profit organisations
In this chapter
Objectives.
•
Performance measurement.
AC
C
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•
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Performance measurement in not-for-profit organisations
•
Objectives
Planning for not-for-profit organisations is
usually more complex.
•
110
It may be difficult to measure objectives
as they are often non-financial (e.g.
a charity may have the aim of reducing
suffering caused by a natural disaster).
Bo
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Performance measurement
Value for money (VFM)
•
Effectiveness – Match the service
provision to the need: how well are the
organisation’s objectives being met?
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Multiple objectives are more common
and it may be difficult to prioritise (e.g.
in a hospital, treating more patients v
better quality care).
Conflicts between stakeholders may be
harder to resolve as the balance of
power is more even. With companies the
shareholders should ‘win’.
AC
C
A
•
Objectives may be politically driven and
hence may change (e.g. government
targets in education).
•
There are greater difficulties in measuring
performance. Companies have profit as
their bottom line measure.
•
There are often different ways of trying to
achieve the same objective – trying to
choose between them can be difficult.
•
Efficiency – Maximize the output of
services for a given level of resource
input.
•
Economy – Source the resource input at
the lowest cost.
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Chapter 13
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
AC
C
A
G
lo
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Woodside charity (June 07)
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AC
C
A
G
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Bo
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Performance measurement in not-for-profit organisations
112
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Performance management
and information systems
In this chapter
•
Performance management information systems.
•
Behavioural aspects of performance management.
•
Sources of management accounting information.
•
Management reports.
AC
C
A
14
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chapter
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Performance management and information systems
Performance management
information systems
STRATEG C PLANN NG
Information requirements at different levels.
AC
C
A
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Information predominantly environmental.
Information impreci e and peculative. Longterm foreca t . Main output target and plan .
Ad hoc control y tem. U e deci ion making
y tem uch a an EIS.
114
MANAGEMENT CONTROL
Information concerned with efficiency and
effective u e of re ource in the whole
organi ation. May involve re pon ibility centre .
Include mea ure of productivity, budget
performance, labour and capacity utili ation. U e
deci ion making y tem uch a a DSS.
OPERAT ONAL CONTROL
Short-term control information.
Very detailed.
May be in term of quantity, rate and time
rather than finance. U e deci ion making
y tem uch a a TPS.
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Chapter 14
•
Open systems interact with their
environment.
•
Closed systems have no contact with the
environment.
Management accounting systems should be
open.
Reflecting environmental changes and
external information.
G
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Bo
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Open and closed systems
AC
C
A
No appropriate accounting system for all
situations.
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Performance management and information systems
Behavioural aspects of performance management
The external environment –
degree of certainty, change
and complexity.
G
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Knowledge and ob ervability –
the extent to which performance
i mea urable.
Bo
x
The design of a management accounting system must take into account human behaviour.
Contingency
theory
AC
C
A
Bu ine unit – organi ation ize,
diver ification and tructure.
Competitive trategy – relative
importance of unit co t and
product differentiation.
Technology –
whether mall
batch or ma
production.
Lean accounting is the application of the idea that accounting systems should be simplified to
remove waste.
116
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Chapter 14
Sources of management accounting information
Information can be obtained from internal and external sources. Much is free, but some comes at a
cost, such as:
most information from business enquiry agents is charged for
•
banks and financial journals often sell surveys and forecasts
•
internet databases may charge a subscription
•
government statistics, forecasts and reports may be charged for.
G
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Internal sources
Bo
x
•
External sources
•
Sales ledger system
•
Purchase ledger system
•
Payroll system
•
Suppliers
•
Newspapers and journals
•
Government
Fixed asset system
•
Customers
•
Production
•
Employees
•
Sales and marketing
•
Banks
•
Business enquiry agents
•
Internet
AC
C
A
•
Information may be qualitative as well as quantitative. Qualitative information, e.g. opinions, still
need to be considered when making a decision.
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Performance management and information systems
Reporting – quantity
and level of detail
118
Co t
Information reporting
y tem – tyle
AC
C
A
Reporting – accuracy
and back-up
G
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Reporting – frequency
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Chapter 14
Management reports
Bo
x
Controlling access to data output reports
Proce ing e.g.
audit trail
G
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Input
e.g. pa word
AC
C
A
Types of Control
Output
e.g. di tribution li t
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Performance management and information systems
Exam focus
(questions from the ACCA Performance Management (PM) exam kit)
CONSTRUCTED RESPONSE QUESTIONS
Bo
x
OBJECTIVE CASE QUESTIONS
QB5 cars eis
AC
C
A
G
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The MG Organisation
120
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INDEX
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I.1
Index
E
Activity based budgeting/costing 66
Activity Based Costing (ABC) 6
Advanced costing methods 5
Aspirations budget 59
Environmental cost accounting 14
expectations budget 59
Expected values 52, 53
Bo
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A
F
B
Factors to consider when changing a
budgetary system 70
Factors to consider when pricing 36
Feed forward control 68
C
H
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Balanced scorecard(KAPLAN and Norton) 97
Behavioural aspects of budgeting 59
Building block model (Fitzgerald et al) 98
AC
C
A
Complementary products 40
Conflicting objectives 60
Cost plus pricing 36
Critical success factors 96
D
Divisional performance measurement 103
High-low 76
I
Incorporating risk and uncertainty 70
Incremental budgeting 62
J
Joint products – the further processing
decision 46
I.2
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Index
N
L
Non-financial performance indicators 96
Learning curves 77
Lifecycle costing 10
Limiting factor analysis 28
Linear programming 29
Liquidity / working capital ratios 95
O
Open and closed systems 115
P
G
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M
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Just-in–time (JiT) 90
AC
C
A
Make v buy 45
Management accounting systems 114
Management styles (Hopwood) 59
Market size and market shares variances 88
Materials mix and yield variances 83
Maximax 53
Maximin 53
Measuring risk 95
Minimax regret 53
Modern manufacturing environments 89
Multi-product decisions 12
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Participation 61
Payoff tables 53
Penetration pricing 39
Performance hierarchy 58
Performance measurement in not-for-profit
organisations 109
Planning and operational variances 86
Planning with limited factors 27
Price discrimination 40
Price elasticity of demand (PED) 36
Price skimming 39
Pricing 35
Product line pricing 40
Profitability ratios 95
Purpose of budgets 58
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I.3
Index
T
Ratio analysis 94
Relevant costing principles 44
Relevant cost pricing 40
Residual Income (RI) 106
Return on Investment (ROI) 105
Risk and uncertainty 49
Target costing 8
Target setting and motivation 59
Targets for controlling production processes
85
Throughput 12
Throughput accounting ratio (TPAR) 13
Total Quality Management (TQM) 89
Transfer pricing 102
V
AC
C
A
Sensitivity 53
Shadow (or dual) prices 32
Shut down decisions 45
Simulation 51
Slack 32
Spreadsheets 71
G
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S
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x
R
I.4
Value for money (VFM) 110
Volume discounts 40
Z
Zero based budgeting 63
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